Corporate Citizens Can Do Well by Doing Good: Richard H. Thaler

By Richard H. Thaler -
Jan 25, 2012

Although the phrase is now somewhat
out of fashion, the issue of corporate responsibility is at the
heart of many of the debates on economic policies around the
world. Should corporations simply maximize profits and let the
invisible hand do its wonders, or do they have some obligation
to be good corporate citizens as well?

As with many politicized debates, this one has been
captured by two extreme positions, neither of which are, to my
mind, particularly sensible.

At one extreme are “pro-responsibility” advocates. This
camp is often pro-free-lunch, too. They think that companies
have a responsibility to pay their workers higher wages, offer
better benefits, yet still keep prices down. Good luck with
that.

At the other extreme, is the “pro-profit” gang. These
folks think that a company’s only responsibilities are to their
shareholders. The pro-profit group worships at the shrine of
Milton Friedman, the both deified and vilified former professor
at the University of Chicago. Friedman called the concept of
corporate responsibility a “fundamentally subversive
doctrine.”

“In a free society,” he said, “there is one and only one
social responsibility of business -- to use its resources and
engage in activities designed to increase its profits so long as
it stays within the rules of the game, which is to say, engages
in open and free competition without deception or fraud.”

Forgotten Qualifiers

Unfortunately, the important qualifiers at the end that
statement are often forgotten. Friedman urges companies to
“stay within the rules of the game” and avoid “deception or
fraud.” So I would like to push back a little on those who
claim to be following Friedman’s tenets and offer my own
alternative, middle-of-the-road view.

Consider this example: A young bank employee, Chris, comes
up with a clever way to increase profit. It is a refinement of
an existing policy that when a customer makes a purchase that
exceeds the account balance on his or her debit card, the bank
allows that purchase to go through, “as a courtesy,” but
charges the customer a $35 penalty for making that purchase, and
the same amount again for additional purchases until the account
is back in the black.

Chris’s idea is that when a bunch of charges come in on the
same day, say when a customer is shopping at the mall, and these
charges will together put the customer over the limit, the bank
will process the biggest purchase first, thus immediately
putting the customer over the limit, and enabling it to charge a
$35 fee for that sandwich at the fast-food joint and another for
the latte at the cafe, and so forth. This policy won’t be
disclosed to customers.

Here is my question: If Chris’ idea is legal and
profitable, is that a sufficient reason for the bank to adopt
it? More generally, is any way of making money acceptable as
long as it is both profitable and legal?

There is an interesting irony here. Those who would favor
this narrow definition of corporate responsibility are typically
very skeptical of governments. Yet, in their worldview, it is
the government that decides the limits of what a company should
do.

If an activity is legal, no matter how unsavory or
unscrupulous it might be, then corporations aren’t merely
allowed to pursue it, it is their corporate responsibility to do
so.

Friedman’s Rule

What would Professor Friedman say about this if he were
still alive? Recall that his rule was that to be responsible, a
practice must avoid deception. Would he consider Chris’ idea
deceptive? I hope so. But the policy I describe is one that was
used by many banks. Bank of America Corp. recently was involved
in a lawsuit in which this strategy was one of the policies
under scrutiny. (Bank of America settled the suit without
admitting any wrongdoing.)

Financial institutions don’t have a monopoly on
questionable business practices. Hiding fees where they are
difficult to find (or decipher) is widespread, from mobile
calling plans to the travel sector. It is easy to find out how
much it will cost to sleep in a hotel, but harder to find out
how much it will cost to park your car, use the Internet or get
a suit cleaned.

So where do I come down on corporate responsibility? Life
is a matter of trade-offs. Yes, corporate officers have a duty
to their shareholders, but they may also want to sleep well at
night. Strategies that enrich shareholders at the expense of
customers, employees, neighbors or the environment require
scrutiny. The bottom line isn’t the only line to consider.

So here is some advice for companies. First, before taking
some action, consider whether you would be willing to publicly
announce the policy to your customers. If not, don’t do it.

Next, instead of encouraging employees to find new ways to
make fees harder to find and more difficult to understand,
concentrate on finding ways to deliver a high quality product at
a competitive price and compete by developing a reputation for
fair dealing.

Yes, at least in the short run you may lose some customers
to competitors whose prices seem cheaper, but in the long run
you may be able to make a profit with loyal customers who are
confident that their pockets aren’t being picked whenever they
let down their guard.

If most companies in an industry fail to take this advice,
they shouldn’t be surprised if they later receive greater
regulatory scrutiny. The Dodd-Frank law came about in part as a
response to practices such as the one I described earlier.

As a matter of logic, if the only standard you are willing
to live by is the letter of the law, then you should expect that
the letter of the law will become increasingly specific.

(Richard H. Thaler is a professor of behavioral science
and economics at the University of Chicago Booth School of
Business and a contributor to Business Class. He is the co-
author, with Cass R. Sunstein, of “Nudge.” The opinions
expressed are his own.)